Question

AB Corporation currently has 40,000 of its 9.5% semi-annual coupon bonds outstanding (Par value = $1,000). The bonds will mature in 20 years and are currently priced at $1,280 per bond. The company has an issue of 1.2 million preferred shares outstanding with a market price of $10.95. The preferred shares offer an annual dividend of $1.05. The company also has 2.5 million shares of common stock outstanding with a price of $26.00 per share. The company is expected to pay a $2.50 common dividend one year from today, and that dividend is expected to increase by 5 percent per year forever. The company typically pays flotation costs of 2% of the price on all newly issued securities.

If the company is subject to a 28 percent marginal tax rate, what is the company’s after-tax, flotation-cost adjusted weighted average cost of capital? Show all steps and calculations clearly.

Present all parts of answers as instructed below.

Cost of Debt (in %) : [Type here] [Round this figure to 2 decimal places.] (1 mark)

Formula used and the values of all parts:

[Type here]

Cost of preferred stock (in %) : [Type here] [Round this figure to 2 decimal places.] (1 mark)

Formula used and the values of all parts: (1 mark)

[Type here]

Cost of common stock (in %) : [Type here] [Round this figure to 2 decimal places.] (1 mark)

Formula used and the values of all parts:

[Type here]

WACC (in %) : [Type here] [Round this figure to 2 decimal places.] (1 mark)

Formula used and the values of all parts: (1 mark)

[Type here]

Answer 1

before tax cost of debt = 7.10%

after tax cost of debt = 7.1%(1-0.28) =5.11%

b)cost of preference shares = dividend/ market price

=1.05/(10.95-10.95*2%)

=9.78%

c)cost equity = expected dividend/ (cmp-floatation cost) + growth rate

=2.5/(26*0.98) + 0.05

=14.81%

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